Restauarant and Retail - LOIs, TIs, Variances, and Leases

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Greg Scharlemann

Rental Property Investor · San Francisco Bay Area, CA · Member since 2009 · 48 posts · 21 votes

9y

Joel gives great feedback. I'll only add a few more thoughts. Does the restaurateur have a track record? I'd be weary of converting the retail space to a restaurant unless there is a successful track record and the area will support a restaurant. Most restaurants fail so you should be mentally prepared to have to replace it sometime in the future. Hopefully most of the improvements are reusable for a future restaurant and in many cases they will be unless they install a bunch of hoods and table top grills at the seats. Assuming the place will be successful you can maximize your exit with higher rents at the end of the term. If you give free rent or discounted rent in the first year you may be able to get larger bumps later in the term. The only risk with this approach is if the restaurant fails or struggles later in the term.

Joel OwensBusiness Member

Moderator

Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes

9y

Will look at if you are urban,suburban,etc. with location and then you want to look at median income and population levels in a 1,3,5 mile radius.

If urban core block by block. Do you have adequate parking or is everything walk able in the area? What concept is the operator wanting to open? Is it for a day or night time crowd?

You then need to look at the concept and if it makes sense. For example the operator that wants to lease from you wants to do a night time Italian dinner place. Research shows there are already 10 Italian places within a few blocks. To make sales and penetrate that market will be very tough to do. That versus no Mexican place in the area in site. The demand will likely be high pushing sales and probably not have to use coupons as much because of little to no competition.

NNN Invest53 Reviews

Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes

9y

I love when tenants improve my properties! I would make sure you get to sign off on the plans and all work is done by licensed pro's. As Joel mentioned, I am not a huge fan of giving money upfront. If they insist, you can opt to pay for some of the improvements that stay with the property and will add value. For example, you pay for fire suppression or remodeling the bathrooms. This way, they can't blow your money or take it and run.

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

@Ash Patel @Greg Scharlemann Originally posted by @Joel Owens:

You could possibly give them a little lower rent the first year and have them do the build out and pay for all of it. You could have 3% rental increases each year instead of 2% so that your blended return is higher over time and when you sell years later. Rent doesn't usually start during build out as they have not taken occupancy yet to open for business with a certificate of occupancy. It is typical sometimes to give 1 or 2 months free rent after they open.

In the lease MAKE SURE tenant is required to disclose monthly and annual sales. This is important so you can monitor their annual rent to sales ratio.

Example 100,000 rent and 1,000,000 sales is a 10% rent to sales ratio. Usually do not want the percentage much higher than that because you throw in food and labor cost and the profit starts getting tight. When you go to sell it will be a plus to a buyer and the lender that you have ongoing sales. You need penalties if tenant does not disclose proper sales figures etc.

Really need an attorney to draft a good lease in the landlord's favor. If NNN lease have no cap on the property taxes each year.

No legal advice given.

Joel, ash and greg. Thanks for the advice.

I was just having my broker draft the LOI... but I will have a lawyer look at it as well.

The 10% rent to sales makes sense I need to figure out whether we give them less space or lower the rent as they want.

@Joel Owens wrote: If urban core block by block. Do you have adequate parking or is everything walk able in the area? What concept is the operator wanting to open? Is it for a day or night time crowd?

It's fairly dense area. Urban. No parking but fairly walkable area. They want to open an asian noodle place which serves alcohol. Currently it's just zoned retail so it would require some CUP or change in variance. I assume it's a day and night crowd.
There's also a college about 8 minutes drive away so they may want to appeal to them

They wanted 3% raise/ year after the first 5 years.

Right now we seem to be agreeing to go do $2.50/ sf + NNN CAM of about $.45/sf. 1st 11 months free (i originally thought 4 months )then the rent kicks in.

They want $40k for TI. After their 250k build out is done

Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes

9y

$3/ft after 11 months free and $40k TI is very generous of you. I am assuming the space is currently white boxed? I would make sure a good portion of that $250k goes towards improving the space in a manner that is acceptable to the next tenant. I am also assuming the tenant has other locations and this is not a startup? What is the length of the lease and renewal options?

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

The space is actually partially gutted. Down to studs in 30% of space and will require new electric, almost all new plumbing--drains and water repipe. No HVAC.

I think it needs a bout 30k+ to bring it up to a shell for any tenant, possibly more....

They don't have other locations but have a lot of financing and some partners are restraunteers.

Option: 5 years lease then 5 year option raised 9% on 6th year

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

@Ash Patel do you think I'm being too generous? It does need about $35k or more work just to bring it up to white box standards. Theres only partial electrical and most has been gutted by previous tenant.

Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes

9y

@Will F. The $40k seems justified if the place is less than white boxed. 5 year with just one renewal also sounds good. If you are making a decent amount off of these numbers, I say go for it. If I get a qualified tenant in front of me for a vacant space, I do whatever I can to close the deal. I don't believe it pays to be greedy. Make sure you have some guarantees, personal or credit worthy and established companies that sign as a guarantor. I would be pretty stoked if someone was putting $250k into one of my properties.

I would also make sure you define what stays behind after they leave. HVAC, hood, fire suppression, sound system, cctv etc. Good luck!

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

Gotcha thanks. That's how I felt since they're spending the majority of the money. I will be crediting them 6 months for the build out and 5 months of free rent.

The only main concern I have now is that they want a 60 day contingency to check with city etc

Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes

9y

@Will F.60 days sounds like a lot but you are in LA. In smaller cities, you talk to the zoning director and building dept within 10 days. Approvals can take a max of 30 days. What I would do is sign the lease and allow them a timed clause to back out if the city denies their permit. Stand your ground on this one.

Account Closed

Investor · Princeton, TX · Member since 2014 · 1k+ posts · 1k+ votes

9y

@Will F. Since you mentioned you wanted it converted to a restaurant, you should probably wait the 60 days.

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

OK I thought perhaps there could be a clause or deposit, but perhaps I'm asking too much.

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

@Joel Owens What do you think of breakup clauses during CUP/ variance DD periods?

It's loooong 60 days they want with free to get out if they can't get their permits/ CUP.

They're going for full restaurant and right now zoned general retail. Problem is if it falls out for any reason they can simply end it and I lose all the time/rents

Thank you

Joel OwensBusiness Member

Moderator

Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes

9y

On my retail developments it's the same thing. Have a national chain right now where they have to agree for the site with the franchisee that wants to put a store there. They also need to get approval for a drive thru with zoning.

They do not want to buy the land until that happens. That process is about 60 days. A lot depends on if you have a ton of back up tenants ready to go in.

Any other tenant will also want time to get approvals. If the restaurant cannot get the type they want then it affects their sales projections and what they could pay in rent for the property if they still went ahead.

Buyer has to spend money for zoning,engineering,attorney fees etc. so it is not like they have no money into it.

NNN Invest53 Reviews

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

Thanks for sound advice. I get it now.

I'll let them try for approval w 60 day DD.

Man, I guess I should have just leased to a clothing tenant... they would have likely paid more, but now I'm invested (time)

Joel OwensBusiness Member

Moderator

Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes

9y

Clothing tenant you would need to see how strong of a guaranty with liquidity and net worth.

That is a very tough business with clothing and most are going to owning small warehouses locally to ship with a smaller retail footprint close by.

Most of those type businesses will be mainly online in 5 to 10 years with quick shipping.

Food people need to go in to eat unless getting take out but by time you get it home it is not as fresh.

NNN Invest53 Reviews

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

Hey @Joel Owens @Ash Patel and others.

I have a space that is gutted- electric, down to studs etc. Would it make sense to just clean it up and list for lease, or do you generally "white box " it so it can seem more attractive to tenants?

I can see the value in white boxing it, but I also don't want to get things done only to have it re-gutted. What is the general "white box" criteria for listing.

Any advice for a commercial novice?

Joel OwensBusiness Member

Moderator

Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes

9y

Situation varies by space. Have a local tenant rep broker do a void analysis and opinion on which way to optimally approach the space.

NNN Invest53 Reviews

Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes

9y

You can always polish up the areas that will be "permanent". Exterior, lighting, windows, parking lot. It does suck to throw money into vacant space. I would make sure there are dusk to dawn lights so the place doesn't look vacant to people driving by at night. Perception is huge.

Ariel Jeidel

Rental Property Investor · NY · Member since 2015 · 49 posts · 20 votes

9y

It really depends on the space. We generally find that any tenant that is worth spending money on for their build out, is also someone who understands size and space and they don't need to see a white box to be interested. That being said we operate in areas where we don't have tenants banging down our doors, so we don't like spending money unless we are very comfortable that we will get it back.

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

Joel and @Ash Patel, your advice has been spot on. I've been juggling tenants with several little retail spaces and just having them fall out due to financing, bad projections, and just random personal/business issues.

@Joel Owens

Background: The location is pretty sound and bound to improve more. This area is a up and coming area- a lot of hipsters, artist types and definitely getting more trendy. It's still got a way to go, but the building itself has a lot of deferred maintenance. A lot of young people with money moving to the area, and it's already a residentially expensive neighborhood.

We're most likely going to get a creative type here, with smaller local branding. But anything that gets built in this neighborhood relating to food or services tends to do really well (obviously if they operate well and design the space in a trendy way).

Update: We had 4 empty spaces. 2 small spaces have rented and we're in a contingency on another space. A final space, which has been gutted to the studs is going back to market because of personal issues with the possible restaurant. They're backing out and we're going to put it back on market in a couple months. I'm contemplating at least putting up drywall or cleaning the space up a bit for future showings.

We have a few tenants lined up, but some are months behind on their process. So it's kind of hard to lock them in while they're still working on their business or getting financials setup for build outs.

Also in the meantime we're doing many upgrades to the 'permanent' parts of the building. I updated exterior lighting as Ash suggested.

CAM/ NNN: We are setting up any leases with basic cam charges- insurance, tax, basic maintenance. A lot of tenants seem to think that's unfair, but really these are actual costs for operating and maintaining the building. Any suggestions on negotiating this or explaining these real costs to tenants?

Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes

9y

@Will F. - Good work!

You can phase in the CAM charges slowly. "New" business owners are likely nervous about opening a new location. Maybe extend their lease one year but give them a break on first year CAM's. I assume most utilities are separated out?

OP

Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes

9y

That's one major issue is gas/ water not separate. Electric has been upgraded so it is.

Kyle Erthner

Real Estate Broker · San Diego, CA · Member since 2017 · 6 posts · 3 votes

9y

It may be a good idea to get renderings for what the space COULD look like to paint the picture for potential tenants of what THEY can make the space into with some reasonable investment. Sometimes it's hard for people to visualize how a space can be transformed when it's in shell condition.